When you lease a car, you don’t own it. Instead, the leasing company owns the car and you’re simply paying to use the car for a predetermined amount of time. The amount that you pay is equal to the amount of value the car will lose over the time that you use it, plus interest, taxes and fees.
Leasing can help you get into a more expensive vehicle for less money each month. That doesn’t mean it’s the less expensive option overall! Only that it may be less intensive on your monthly cash flow. Let's talk about the various components of a lease.
As discussed in the previous section, depreciation is the amount of value a car loses over time. Resale value (also called residual value) is how much a used car can be sold for. When you lease a car, you’re paying the leasing company the difference between the car’s current sale price and its predicted residual value at the end of the lease.
But how does a leasing company know how much your car will be worth at the end of your lease? They don’t. It’s a guess based on data and current market conditions (which could change by the time your lease is over), and it’s all technically negotiable.
Leasing is commonly perceived as the more flexible option (compared to financing) in large part because leasing makes it easier to have a new car every few years. It can also insulate you from cars that depreciate a lot, with many leasing companies giving generous assumptions about future resale value, which creates less of a difference between the sale price and the residual, which in turn lowers the lease payments. In reality though, leasing can be quite restrictive.
One of the ways the leasing company estimates the future value of a car is to predetermine certain variables. The leasing company will ask you to agree to these predetermined variables at the start of your lease. Let’s look at each.
Typical leases last for 24, 36 or 48 months. At the end of the lease term, you give the car back like returning a rental car. Since you never owned the car, you walk away with nothing. Lease companies make it very difficult to end a lease early. Some don’t allow this at all, and others will charge expensive early termination fees.
Leases typically offer 10,000, 12,000 or 15,000 miles per year. More mileage will decrease the car’s future value, which will increase your monthly payment. If you put more mileage on the car than agreed upon at the start of the lease, you will be charged extra for every mile above and beyond what you originally agreed. The amount that you’re charged for each extra mile is defined in your lease contract, and will vary by leasing company. If you return a car with less mileage than originally agreed, you get nothing in return (some leasing companies will reimburse some money for a car that is returned with fewer miles than agreed, but this is not the norm, and they are not obligated to do so). It’s a bit of a gamble to guess how much you might need to drive a car over the course of several years, as life can certainly change in that time frame.
You can be charged at the end of your lease for any damage or use that is considered excessive wear and tear. This can include scratches, dents, malfunctioning items, odors, etc. As your lease is about to end, a leasing company will schedule an inspection of the car, and someone will go over the car inside and out looking for signs of damage. If found, you’ll have to have the damage fixed or you’ll receive a bill for the repair of that item from the leasing company.
When figuring out how much a lease will cost, you’ll need to apply Money Factor. Money Factor is a finance charge, essentially interest that you pay on the lease. If you multiply the money factor by 2400, the result will be expressed as annual percentage rate (APR).
Let’s give that a try. Let’s say the money factor on a lease is .00250. If we multiple .00250 by 2400, we get 6. That means this lease has an APR of 6%.
Many dealers will tell you that the Money Factor is not negotiable, as this is a standard number handed down by the leasing company at the beginning of each month. While the Money Factor isn't likely to be negotiatable, there could still be ways to lower it...
Just like the interest rate on a loan, your money factor could be impacted by your credit score. If your credit score isn’t the best, you may choose to utilize a co-signer on the lease. A co-signer is someone who is essentially using their credit worthiness to vouch for yours. When someone co-signs a loan or lease, they are taking on all of the same responsibilities that you are.
A co-signer can help you achieve a lower money factor (or loan interest rate, if buying instead of leasing), but know that you’re asking the co-signer to literally put their own credit on the line to do so.
Some leasing companies will allow you to place a security deposit on your lease, which may lower the money factor. At the end of the lease, assuming all payments were made on time, you would receive your security deposit back in full.
While rare, some leasing companies allow you to place higher deposits than required, or multiple deposits. This can help lower the money factor even more. This may not be necessary if you have a very good credit score.
When it’s time for the lease to end and for the car to be returned, the leasing company will schedule an inspection of the vehicle.
If there is any damage or excess wear on the vehicle that may need to be fixed, it’s a good idea to have this inspection done a few weeks in advance of turning the car in to the dealership. That way, you have options to have the car fixed somewhere and not just pay whatever the leasing company says it costs to repair.
When it’s time to return the car, the leasee (you) will typically owe the following:
The leasing company may offer to waive these fees if you lease another car from them. Some leases, but not all, give you the option to buy the car after the lease is over. Buying the car is one way to avoid having to pay fees for excess mileage and/or wear and tear, but doing so may not be a favorable deal.
Remember that when you started your lease, you agreed to a number that the car would be worth at the end of the lease (called the "Residual value"). This number is very important, because not only did it determine what your lease payments would be, it also set the price for the car in the future. This is the price that you would pay if you were to buy the car at the end of the lease, often called the "Buyout Price".
When beginning your lease, it was in your interest to predict the car would hold its value very well, because a higher value at the end would mean you're paying for less depreciation over time, which translates to lower monthly lease payments. Now at the end of the lease, the actual value of the car may be higher or lower than predicted. If the actual value is higher than your buyout price, buying the car can be a good deal.
More often than not, the car's actual value will be less than the buyout price. In this case, if you were to buy the car, you would be paying more for it than it's currently worth. Who would do such a thing? Well, let's look at 2 scenarios.
Let's say the car is worth $1,000 less than your buyout price, and you also went over your mileage allowance. The extra mileage is going to cost you $1,500 in fees. You could pay the $1,500 and walk away from the car, or you could buy the car. When you buy the car, you no longer owe those excess mileage fees. In this scenario, buying the car saved you $500 because you've paid $1,000 more than the car is worth, but avoided having to pay $1,500 in fees. You'll probably only consider an option like this if you like the car and want to keep it, but assuming that's true this could make some degree of financial sense. Keep in mind however, not only have you paid $1,000 more than a car is worth, but you've also added more mileage than expected to that car - which reduces its value further. If you plan to drive the car for many more years, this may not matter to you.
For many leasees, they get caught in a trap. They lease a car because it's a cheaper monthly payment. Leasing companies may offer aggressively priced leases at $99/mo, and many people will sign up for this because it's their easiest way to get reliable transportation they can afford. Some of these people will go over their mileage or damage the car, and get hit with fees at the end. For these people, the fees at the end of the lease may not be affordable. If they can't afford to pay those fees, they may choose to buy the car instead. This is how people get trapped in a car they don't want, paying more than it's worth, and unable to get out from under it because they cannot afford to come up with the difference between what they owe on the car and what they can sell it for.
So the lesson here is, always be aware of your lease terms, and only lease a vehicle if it fits your life. Be honest about your mileage needs, even if it costs a little more to get more mileage. Take extra care of the car while you have it, avoiding scenarios that might damage the car.
Once you sign a lease, it’s a contract to keep the car for a certain amount of time. The only ways to exit a lease agreement are to pay the lease in full (meaning all of the payments combined plus early termination fees) or to transfer the lease to someone else, meaning someone else takes over the contract you originally signed and also takes possession of the car for the remaining lease term.
It should be noted that some leasing companies do not allow you to transfer a lease at all, so this is something to pay attention to before signing.
There are also lease swap marketplaces online that match people who are looking to get out of a lease with people who are looking for shorter term vehicle options than current leases allow. To use a service like this, your leasing company would have to allow transfers and as mentioned, they may not.
So, we just covered all of the fees and restrictions related to leasing and at this point you might be thinking, “why on Earth do people lease cars?” The answer is simple: it can put you in a better car for less money per month. It can also protect you financially from a car that you think may depreciate heavily - even more than what you’re paying for.
Notice, however, that we didn’t say cheaper. When you add up everything, a lease may or may not be the cheaper option. Let’s look at an example.
Let’s say you buy a car for $25,000, paying $700 per month over 36 months. At the end of those 3 years, you still own a car worth, for example, $16,000. If you sell the car for that price, you’ve spent just $9,000 total.
Now let’s say you lease that same car for 3 years instead, paying only $400 per month. The payment is cheaper, which is great, but at the end of the lease you’ve paid $14,400 and you’re left with nothing. In this instance, it was cheaper to buy the car.
But what if the car depreciates heavily? Let's say that $25,000 car had a resale value after 3 years equal to the worst EV residual on the market. That car would be worth only ~$11,000. If you sold that car for $11,000, you've spent a total of $15,000. In this instance, leasing would have been cheaper.
Here it’s easy to see that the price you can sell the car for in the end really is the big question. Cars with heavy depreciation may be cheaper to lease, while cars with strong resale value may be cheaper to buy. It's all a bit of a guess, since nobody can be absolutely sure what the resale value of a car will be after few years.
When it comes to leasing an EV specifically, there are a few things to consider.
Historically, EVs do not have the best resale value. This is likely because most EVs to date have been early technology cars with less-than-ideal amounts of range that only suit certain low-mileage lifestyles. As a result, the value of an EV can drop pretty heavily. There are exceptions: cars with over 200 miles of range have generally held their value pretty well, and so there’s a strong case to be made that EVs going forward will have more resilient values as they’re more usable for more people. For now, it’s worth knowing that EV values, especially those on lower range vehicles, are unpredictable at best.
When you buy a qualifying EV, you’re eligible for an EV tax credit up to $7,500. We’ll explain how the credit works later in this lesson, but for now know that when you lease a car, it’s the leasing company who claims this credit - not the leasee (you). With that said, many leasing companies are willing to discount the lease in the amount of the tax credit. This can be an advantage for leasing if you don’t have enough tax liability to take advantage of the full tax credit, or if you’d prefer the credit be an instant savings (instead of waiting for tax season to see a savings). More on this in a bit.
While not that common, there is a new way to drive off the lot with a car that’s gaining some popularity. They’re called subscriptions, and they look at your car more like a cell phone plan than an auto loan.
Subscriptions share some common traits with leasing. For example, with a subscription you do not own the car, you are simply paying a fee to drive it for some period of time. Subscriptions tend to be shorter than leases, some even going month-to-month after some initial start-up fees and others renewing at 1 or 2 years.
Some of these subscriptions include other costs like maintenance and insurance as included. For this reason, they tend to cost more per month than a lease payment.
If all of this sounds a little vague, it’s because subscriptions are a relatively new thing and each company is approaching them a little differently. Some automakers limit their subscription programs to specific regions of the country, and some are sold as luxury packages where they will valet different car models to your door based on your preference at any given time (for example, swapping an SUV for a sports car for the weekend).
If you hear about subscriptions, our best advice is to proceed with caution.